5-2 Consumer Credit Chapter Learning Objectives LO5.1Analyze advantages and disadvantages of using consumer credit LO5.2Assess the types and sources of consumer credit LO5.3Determine whether you can afford a loan and how to apply for credit LO5.4Determine the cost of credit by calculating interest using various interest formulas LO5.5Develop a plan to protect your credit and manage your debts
5-3 Learning Objective LO5.1 Analyze Advantages and Disadvantages of Using Consumer Credit Credit –An arrangement to receive cash, goods or services now, and pay for them in the future –Based on trust in people’s ability and willingness to pay bills when due Consumer credit –Use of credit by individuals for personal needs, except a home mortgage –A questionable force in our economyquestionable
5-4 Uses and Misuses of Credit Before you use credit for a major purchase, consider: –Do I have the cash for the down payment? –Do I want to use my savings for this purchase? –Does the purchase fit my budget? –Could I use the credit I’ll need in some better way? –Can I postpone this purchase? –What are the opportunity costs of postponing this purchase? –What are the dollar and psychological costs of using credit for this purchase?
5-5 Advantages of Credit Current use of goods and services Permits purchase even when funds are low A cushion for financial emergencies Advance notice of sales Easier to return merchandise Convenient when shopping Provides a record of expenses
5-6 Advantages of Credit - Continued One monthly payment Safer than carrying cash Needed for hotel reservations, car rentals, and shopping online Take advantage of float time/grace period Rebates, airline miles, or other bonuses Credit indicates financial stability
5-7 Disadvantages of Consumer Credit Temptation to overspend Can create long-term financial problems and slow progress toward financial goals Potential loss of merchandise due to late or non-payment Ties up future income Credit costs money - more costly than paying with cash
5-8 Learning Objective LO5.2 Assess the Types & Sources of Consumer Credit Two Basic Types of Consumer Credit Closed-End Credit –One-time loans for a specific purpose and a specific amount paid back in a specified period of time Open-End Credit –Use as needed until line of credit max reached
5-9 Closed-End Credit One-time loans for a specific purpose that you pay back in a specified period of time, and in payments of equal amounts Mortgage, automobile, and installment loans for furniture, appliances and electronics 3 most common types of closed-end credit 1. Installment sales credit - Physical Asset 2. Installment cash credit - Cash 3. Single lump-sum credit – Payday Loan
5-10 Open-End Credit Use as needed until line of credit max reached –Credit cards –Department store cards –Home equity loans You pay interest and finance charges if you do not pay the bill in full when due Revolving check credit also called Bank line of credit – Requires special checks and is an installment loan.
5-11 Credit Cards Average cardholder has > 9 credit cards Convenience users vs. Borrowers Finance charge = total amount paid to use credit –“Teaser rates” Reward programs
5-12 Credit-Type Cards Debit Cards –Debit cards electronically subtract money from your savings or checking accounts –In the past they were most commonly used at ATMs Stored Value Cards –Gift cards –Prepaid cards
5-13 Credit-Type Cards Smart Cards –Plastic card equipped with a computer chip that can store 500 times as much data as a normal credit card Travel and Entertainment (T&E) cards –Not really “credit cards”; balance is due in full each month –Diners Club; American Express –You don’t pay for services or goods at the time you purchase them
5-14 Sources of Consumer Credit Loans –Borrowing money with an agreement to repay along with interest within a certain amount of time Inexpensive loans –Parents or family members Medium-priced loans –Commercial banks, savings and loan associations, and credit unions Expensive loans –Finance and check cashing companies –Retailers such as car or appliance dealers –Bank credit cards and cash advances –Mob loan sharks
5-15 Home Equity Loans –Loan based on your home equity Current market value of your home minus the amount you still owe on the mortgage –Interest is tax deductible –Should only be used for major purchases Sources of Consumer Credit
5-16 Learning Objective LO5.3 Determine Whether You Can Afford a Loan and How to Apply for Credit Before you take out a loan, ask yourself... Can you meet all your essential expenses and still afford the monthly loan payments ? –What do you plan to give up in order to make the payment?
5-17 General Rules of Credit Capacity * Not including house payment, which is a long-term liability Debt Payments-to-Income Ratio Monthly Debt Payments* Net Monthly Income Consumer credit payments should not exceed a maximum of 20% of your net income.
5-18 General Rules of Credit Capacity Debt To Equity Ratio Total Liabilities Net Worth* = Should be < 1 *Excluding home value
5-19 The Five C’s of Credit Character – Will you repay the loan? Capacity – Can you repay the loan? Capital – What are your assets and net worth? Collateral – What if you don’t repay the loan? Conditions – What if your job is insecure?
5-20 Your Credit Report Credit Report or Credit File –Record of your complete credit history Credit Bureaus –Agencies that collect information on how promptly people and businesses pay their bills –Experian, Trans Union and Equifax are the 3 major credit bureaus –Credit Bureaus obtain information from banks, finance companies stores, credit card companies and other lenders
5-21 Your Credit Report Credit Files –Typically contain detailed credit data along with considerable personal information: Name, address, SSN, DOB (self & spouse) Employer, position and income (current & previous, self and spouse) Home owner or renter Checks returned for insufficient funds
5-22 Your Credit Report Fair Credit Reporting Act (1971) –Law requires out-of-date information to be deleted –Gives consumers access and the ability to correct misinformation –Places limits on who can obtain your credit report
5-23 Your Credit Report Who can obtain a credit report? – Only authorized persons have access to your report for approved legitimate business purposes Time Limits on Unfavorable Data – Adverse data can be reported for 7 years – Bankruptcy can be reported for 10 years – Exceptions: Application for credit >$75,000 Application for life insurance >$150,000
5-24 Your Credit Report Incorrect Information in Your File –You may request a copy of your credit information within 60 days of being denied credit –You may request a free copy of your credit report annually What are Your Legal Rights? You have the legal right to sue the credit bureau or the creditor that has caused you harm
5-25 FICO & VantageScore FICO Credit Score –350 to 850 –Higher score = less risk –Available from http://www.myfico.com for a feehttp://www.myfico.com VantageScore –New scoring technique –Developed collaboratively by 3 credit agencies –Range = 501 to 990 PRBC = Payment Reporting Builds Credit system will check on payment history not normally included in above (rent, phone)
5-26 Factors of Creditworthiness ECOA (Equal Credit Opportunity Act) –Gives all applicants the same rights –Credit providers may not discriminate based on: Age Social Security or public assistance Housing loans (redlining) –If you are denied credit, you have the right to know the reasons You can request a copy of your credit report within 60 days if you are denied credit based on what is in your files
5-27 If You are Denied Credit
5-28 Risk-based pricing –Differentiate customers based on credit information –Charge higher rates to riskier customers –Effective January 1, 2011, lenders must disclose details to customers if risk-based pricing is used –Customers not receiving the best rate must be advised of their credit score Factors of Creditworthiness
5-29 Learning Objective LO5.4 Determine the Cost of Credit by Calculating Interest Using Various Interest Formulas Finance charge – Total dollar amount you pay to use credit – Includes interest costs and fees, such as service charges, credit-related insurance premiums, or appraisal fees Annual Percentage Yield (APY) – Percentage cost of credit on a yearly basis – Key to comparing costs when shopping for rates It is important to shop for credit
5-30 Tackling the Trade-Offs Term (length of loan) versus interest costs Lender risk versus interest rate To reduce the lender’s risk and thus the interest rate you can: –Accept a variable interest rate –Provide collateral to secure a loan –Provide up-front cash –Take a shorter term loan
5-31 Calculating the Cost of Credit Simple interest –Computed on principal only without compounding –The dollar cost of borrowing –Interest = Principal x rate x time Simple interest on the declining balance –Interest is paid only on the amount of original principal not yet repaid Add-on interest –Interest calculated on full amount of principal –Interest added to original principal –Payment = Total divided by number of payments to be made
5-32 Calculating the Cost of Credit Cost of Open-End Credit –Truth in Lending Act requires that open-end creditors inform consumers how the finance charge and APR will affect their costs Cost of Credit and Expected Inflation –Lenders incorporate the expected rate of inflation when deciding how much interest to charge Avoid the Minimum Monthly Payment Trap –The longer you take to pay off the bill, the more interest you pay
5-33 Learning Objective LO5.5 Develop a Plan to Protect Your Credit and Manage Your Debts Fair Credit Billing Act (FCBA, 1975) Notify creditor of error in writing within 60 days Pay the portion of the bill not in dispute Creditor must respond within 30 days Credit card company has two billing periods but no longer than 90 days to correct your account or tell you why they think the bill is correct
5-34 Protecting Your Credit Disputed item won’t affect your credit rating while in dispute Can withhold payment on damaged or shoddy goods or poor services if purchased with a credit card Must make sincere attempt to resolve problem with creditor Fair Credit Billing Act (FCBA, 1975)
5-35 What to Do If Your Identity is Stolen? Contact the three major credit bureaus –Ask the fraud department to institute a fraud alert –Request that creditors call you for permission before opening any new accounts in your name Contact creditors –Check for any accounts that have been tampered with or opened fraudulently File a police report –Keep a copy
5-36 Protecting Your Credit From Theft or Loss Shred any papers that contain personal information Close your accounts immediately if you suspect an identity thief has accessed the account Be sure your credit card is returned after a purchase Keep a record of credit card numbers Notify your credit card company immediately if your card is lost or stolen
5-37 Protecting Your Credit Information on The Internet Use a secure browser Keep records of online transactions Review monthly bank and credit card statements Read the privacy and security policies of websites you visit Keep personal information private Never give your password to anyone Don’t download files sent by strangers
5-38 Co-signing a Loan Co-signing means guaranteeing the debt –Lender would not require a co-signer if borrower were a good risk –Can you afford it if the borrower defaults? If borrower doesn’t pay, cosigner is liable for the full amount plus any late or collection fees If payment is missed, creditor can collect from the cosigner first
5-39 Complaining About Consumer Credit First: Try to solve the problem directly with the creditor If that fails: Use formal complaint procedures A variety of Consumer Credit Protection Laws and Federal Agencies administer and assist with complaint procedures
5-40 Consumer Credit Protection Laws Truth in Lending and Consumer Leasing Acts Fair Credit and Charge Card Disclosure Act Equal Credit Opportunity Act (ECOA) Fair Credit Billing Act Fair Credit Reporting Act Consumer Credit Reporting Reform Act (1977) Electronic Funds Transfer Act Credit Card Accountability Responsibility and Disclosure Act of 2009 (Card Act) –45 days notice of rate increases –More detailed statements
5-41 Your Rights Under Consumer Credit Laws Complain to the creditor File a complaint with the government If all else fails, sue the creditor Consumer Financial Protection Bureau (CFPB) –Credit card issues –https://help.consumerfinance.gov/app/ask_cc_complainthttps://help.consumerfinance.gov/app/ask_cc_complaint
5-42 Managing Your Debts Warning Signs of Debt Problems Paying only the minimum balance each month Trouble even paying the minimum balance Total balance increases every month Missing loan payments or paying late Using savings to pay for necessities Getting second or third payment notices Borrowing money to pay old debts Exceeding the credit limits on your credit cards Denied credit due to a bad credit report
5-43 Managing Your Debts Debt Collection Practices The Federal Trade Commission enforces the Fair Debt Collection Practices Act (FDCPA) –Prohibits certain practices by debt collectors –Does not eliminate legitimate debts
5-44 Financial Counseling Services Consumer Credit Counseling Services (CCCS)CCCS – Non-profit and supported by contributions from banks, merchants, etc. –Provides education about credit –Provides help with spending plan –Provides debt counseling services for those with serious financial problems –Can develop a debt consolidation plan and negotiate reduced interest rates
5-45 Other Counseling Services Universities, local county extension agents, credit unions, military bases, and state and federal housing authorities provide nonprofit counseling services Check with your financial institution or consumer protection office for a list of reputable, low-cost financial counseling services
5-46 Declaring Personal Bankruptcy U.S. Bankruptcy Act of 1978 Chapter 7 = straight bankruptcy Chapter 13 = wage earner plan Bankruptcy should be the last resort, because of the damage to your credit rating Personal bankruptcy is a procedure to distribute some or all of your assets among creditors
5-47 Chapter 7 Bankruptcy Submit a petition to the court that lists assets and liabilities, and pay a filing fee Many, but not all, debts are forgiven Assets may be sold to pay creditors Can keep some assets (home, vehicle,..) Intent = a fresh start Most filed are this type
5-48 After Chapter 7 You May No Longer Owe: – Retail store charges – Bank credit card charges – Unsecured loans – Unpaid hospital or physician bills You Still May Owe... –Certain taxes and fines –Child support and alimony –Educational loans –Debts from willful or malicious acts
5-49 Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Makes it more difficult for consumers to file a Chapter 7 bankruptcy –Forces a Chapter 13 repayment plan –Debtors must wait 8 years from their last bankruptcy to file again –Clamps down on “bankruptcy mills” that seek to game the system –Includes provisions for consumer education on debt management and financial planning
5-50 Chapter 13 Bankruptcy Debtor with regular income proposes a plan to eliminate his debts over time Information provided to the court the same as under Chapter 7 Plan may last up to five years Debtor makes payments to a court-appointed trustee
5-51 Effects of Bankruptcy Obtaining credit may be more difficult But, creditors may consider the inability to file bankruptcy again for 8 years Credit could be easier for Chapter 13 filers who have repaid some debt versus Chapter 7 filers who made no effort to repay
5-52 Chapter Summary Learning Objective LO5.1 Consumer credit is the use of credit by individuals and families for personal needs. The advantages of using credit include: –The ability to purchase goods when needed and pay for them gradually –The ability to meet financial emergencies –Convenience in shopping –Establishment of a credit rating The disadvantages of using credit include: –Credit costs money –Encourages overspending –Ties up future income
5-53 Chapter Summary Learning Objective LO5.2 Closed-end and open-end credit are two types of consumer credit. –Closed-end credit: borrower pays back a one-time loan in a stated period of time, with a specified number of payments. –Open-end credit: borrower is permitted to take loans on a continuous basis and is billed for partial payments periodically. Major sources of consumer credit include commercial banks, savings and loan associations, credit unions, finance companies, life insurance companies, and family and friends. –Parents or family members are often the source of the least expensive loans.
5-54 Chapter Summary Learning Objective LO5.3 Two general rules for measuring credit capacity: –Debt payments-to income ratio –Debt-to-equity ratio Creditors seek information from one of the three national credit bureaus or a regional credit bureau Creditors determine creditworthiness on the basis of the five Cs: –Character –Capacity –Capital –Collateral –Conditions
5-55 Chapter Summary Learning Objective LO5.4 Compare the finance charge and the annual percentage rate (APR) as you shop for credit. Under the Truth in Lending Act, creditors are required to state the cost of borrowing so that you can compare credit costs and shop for credit.
5-56 Chapter Summary Learning Objective LO5.5 If a billing error occurs on your account, notify the creditor in writing within 60 days. If the dispute is not settled in your favor, you can place your version of it in your credit file. You may also withhold payment on any defective goods or services you have purchased with a credit card as long as you have attempted to resolve the problem with the merchant. If you have a complaint about credit, first try to deal directly with the creditor.
5-57 Chapter Summary Learning Objective LO5.5 If that fails, you can turn to the appropriate consumer credit law: –The Truth in Lending Act –The Consumer Leasing Act –The Equal Credit Opportunity Act –The Fair Credit Billing Act –The Fair Credit Reporting Act –The Consumer Credit Reporting Reform Act –The Electronic Fund Transfer Act
5-58 Chapter Summary Learning Objective LO5.5 If you cannot meet your obligations: –Contact your creditors immediately –Contact your local Consumer Credit Counseling Service or other debt counseling organizations A debtor’s last resort is to declare bankruptcy, permitted by the U.S. Bankruptcy Act of 1978 –Consider the financial and other costs of bankruptcy before taking this extreme step –A debtor can declare Chapter 7 (straight) bankruptcy or Chapter 13 (wage earner plan) bankruptcy